Loopholes upon loopholes: Ohio business owners can double benefits from some deductions

Loopholes upon loopholes: Ohio business owners can double benefits from some deductions

Ohio business owners are able to get double tax benefits out of certain deductions to their state income tax, Policy Matters Ohio detailed in a report issued today. They are able to do so by taking advantage of a loophole in the tax break for business owners, often known as the LLC loophole.

Hundreds of thousands of Ohioans may be able to take advantage of the tax law in this way. Though the exact value is difficult to calculate, the practice, available since legislators changed the law in 2015, may be costing the state millions of dollars a year in revenue.

The LLC loophole exempts owners of partnerships, sole proprietorships, S Corporations and limited liability companies from state income tax on the first $250,000 in earnings from such entities (they are known as “passthrough entities” because their owners are taxed on profits from them under the individual income tax as they pass through to them). Income over that amount is taxed at just 3 percent, lower than the nearly 5 percent rate they would otherwise pay. The Department of Taxation estimated the cost of the tax break at $1.086 billion in 2016.

Here’s how some are able to get double tax benefits: Business owners can take tax deductions for health insurance, retirement contributions and half of self-employment tax, much as wage earners do. But in many instances, they may not need to subtract them when separately figuring out their business income. That means their business income is larger than it would otherwise be – and since business owners can deduct $250,000 of such income when they figure how much will be taxable, it means they are effectively getting the benefit of these deductions twice.

“This underlines that Ohio’s income-tax break for business owners is itself riddled with special-interest loopholes unavailable to most Ohio taxpayers,” said Zach Schiller, Policy Matters research director and author of the report. “The LLC loophole has not produced economic results and should be repealed,” Schiller said. “Short of that, it should be tightened up so that business owners are unable to use it in ways that would dumbfound most Ohioans without such artifices available to them.”

Policy Matters Ohio previously described how tens of thousands of affluent business owners who use the passthrough tax break are also claiming other deductions intended for those with lower incomes. Another loophole allows tax filers who own 20 percent of a business to deduct the compensation they are paid, distorting and extending a tax break that is supposed to cover business profits, not salaries.